Acompany raises its capital by means of issue of

Transcription

1 Issue and Redemption of Debentures 2 LEARNING OBJECTIVES After studying this chapter you will be able to : state the meaning of debenture and explain the difference between debentures and shares; describe various types of debentures; record the journal entries for the issue of debentures at par, at a discount and at premium; explain the concept of debentures issued for consideration other than cash and the accounting thereof; explain the concept of issue of debentures as a collateral security and the accounting thereof; record the journal entries for issue of debentures with various terms of issue, terms of redemption; show the items relating to issue of debentures in company s balance sheet; describe the methods of writing-off discount/loss on issue of debentures; explain the methods of redemption of debentures and the accounting thereof; and explain the concept of sinking fund, its use for redemption of debentures and the accounting thereof. Acompany raises its capital by means of issue of shares. But the funds raised by the issue of shares are seldom adequate to meet their long term financial needs of a company. Hence, most companies turn to raising long-term funds also through debentures which are issued either through the route of private placement or by offering the same to the public. The finances raised through debentures are also known as long-term debt. This chapter deals with the accounting treatment of issue and redemption of debentures and other related aspects. SECTION I 2.1 Meaning of Debentures Debenture: The word debenture has been derived from a Latin word debere which means to borrow. Debenture is a written instrument acknowledging a debt under the common seal of the company. It contains a contract for repayment of principal after a specified period or at intervals or at the option of the company and for payment of interest at a fixed rate payable usually either half-yearly or yearly on fixed dates. According to section 2(12) of The Companies Act,1956 Debenture includes Debenture Inventory, Bonds and any other securities of a company whether constituting a charge on the assets of the company or not.

2 Issue and Redemption of Debentures 75 Bond: Bond is also an instrument of acknowledgement of debt. Traditionally, the Government issued bonds, but these days, bonds are also being issued by semi-government and non-governmental organisations. The terms debentures and Bonds are now being used inter-changeably. 2.2 Distinction between Shares and Debentures Ownership: A share represents ownership of the company whereas a debenture is only acknowledgement of Debt. A share is a part of the owned capital whereas a debenture is a part of borrowed capital. Return: The return on shares is known as dividend while the return on debentures is called interest. The rate of return on shares may vary from year to year depending upon the profits of the company but the rate of interest on debentures is prefixed. The payment of dividend is an appropriation of profits, whereas the payment of interest is a charge on profits and is to be paid even if there is no profit. Repayment: Normally, the amount of shares is not returned during the life of the company, whereas, generally, the debentures are issued for a specified period and repayable on the expiry of that period. However, in the year 1998, the amendements (Section 77A and 77 B sub Section 2) in the Companies Act, 1956 permitted companies to buy back its shares specially when market value of shares are less than its book value. Voting Rights: Shareholders enjoy voting rights whereas debentureholders do not normally enjoy any voting right. Rate of Discount on issue: Both shares and debentures can be issued at a discount. However, shares can be issued at discount in accordance with the provisions of Section 79 of The Companies Act, 1956 which stipulates that the rate of discount must not exceed 10% of the face value while debentures can be issued at any rate of discount. Security : Shares are not secured by any charge whereas the debentures are generally secured and carry a fixed or floating charge over the assets of the company. Convertibility: Shares cannot be converted into debentures whereas debentures can be converted into shares if the terms of issue so provide, and in that case these are known as convertible debentures. 2.3 Types of Debentures A company may issue different kinds of debentures which can be classified as under:

3 76 Accountancy : Company Accounts and Analysis of Financial Statements From the Point of view of Security (a) (b) Secured Debentures: Secured debentures refer to those debentures where a charge is created on the assets of the company for the purpose of payment in case of default. The charge may be fixed or floating. A fixed charge is created on a specific asset whereas a floating charge is on the general assets of the company. The fixed charge is created against those assets which are held by a company for use in operations not meant for sale whereas floating charge involves all assets excluding those assigned to the secured creditors Unsecured Debentures: Unsecured debentures do not have a specific charge on the assets of the company. However, a floating charge may be created on these debentures by default. Normally, these kinds of debentures are not issued From the Point of view of Tenure (a) (b) Redeemable Debentures: Redeemable debentures are those which are payable on the expiry of the specific period either in lump sum or in Instalments during the life time of the company. Debentures can be redeemed either at par or at premium. Irredeemable Debentures: Irredeemable debentures are also known as Perpetual Debentures because the company does not give any undertaking for the repayment of money borrowed by issuing such debentures. These debentures are repayable on the winding-up of a company or on the expiry of a long period From the Point of view of Convertibility (a) (b) Convertible Debentures: Debentures which are convertible into equity shares or in any other security either at the option of the company or the debentureholders are called convertible debentures. These debentures are either fully convertible or partly convertible. Non-Convertible Debentures : The debentures which cannot be converted into shares or in any other securities are called nonconvertible debentures. Most debentures issued by companies fall in this category From Coupon Rate Point of view (a) Specific Coupon Rate Debentures: These debentures are issued with a specified rate of interest, which is called the coupon rate. The specified rate may either be fixed or floating. The floating interest rate is usually tagged with the bank rate.

4 Issue and Redemption of Debentures 77 (b) Zero Coupon Rate Debentures: These debentures do not carry a specific rate of interest. In order to compensate the investors, such debentures are issued at substantial discount and the difference between the nominal value and the issue price is treated as the amount of interest related to the duration of the debentures From the view Point of Registration (a) (b) Registered Debentures: Registered debentures are those debentures in respect of which all details including names, addresses and particulars of holding of the debentureholders are entered in a register kept by the company. Such debentures can be transferred only by executing a regular transfer deed. Bearer Debentures: Bearer debentures are the debentures which can be transferred by way of delivery and the company does not keep any record of the debentureholders Interest on debentures is paid to a person who produces the interest coupon attached to such debentures. Types of Debenture/Bond Security Tenure Mode of Coupon Registration Redemption rate Secured/ Unsecured/ Redeemable Perpetual/ Convertible Non- Zero Specific Registered Unregistered/ Mortgage Naked debenture Irredeemable debenture convertible coupon rate debenture Bearer debenture debenture debenture debenture rate/deep debenture Discount Rate Fully convertible debenture Partly convertible debenture 2.4 Issue of Debentures The procedure for the issue of debentures is the same as that for the issue of shares. The intending investors apply for debentures on the basis of the prospectus issued by the company. The company may either ask for the entire amount to be paid on application or by means of instalments on application, on allotment and on various calls. Debentures can be issued at par, at a premium or at a discount. They can also be issued for consideration other than cash or as a collateral security.

5 78 Accountancy : Company Accounts and Analysis of Financial Statements Issue of Debentures for Cash Debentures are said to be issued at par when their issue price is equal to the face value. The journal entries recorded for such issue are as under: (a) (b) (c) Note: If whole amount is received in one instalment: (i) On receipt of the application money Bank A/c To Debenture Application & Allotment A/c (ii) On Allotment of debentures Debenture Application & Allotment A/c To Debentures A/c If debenture amount is received in two instalments: (i) On receipt of application money Bank A/c To Debenture Application A/c (ii) For adjustment of applications money on allotment Debenture Application A/c To Debentures A/c (iii) For allotment money due Debenture Allotment A/c To Debentures A/c (iv) On receipt of allotment money Bank A/c To Debenture Allotment A/c If debenture money is received in more than two instalments Additional entries: (i) On making the first call Debenture First Call A/c To Debentures A/c (ii) On the receipt of the first call Bank A/c To Debenture First Call A/c Similar entries may be made for the second call and final call. However, normally the whole amount is collected on application or in two instalments, i.e., on application and allotment. Illustration 1 ABC Lmited issued Rs 10,000, 12% debentures of Rs 100 each payable Rs 30 on application and remaining amount on allotment. The public applied for 9,000 debentures which were fully allotted, and all the relevant allotment money was duly received. Give journal entries in the books of ABC Ltd., and exhibit the relevent information in the balance sheet.

6 Issue and Redemption of Debentures 79 Solution: Books of ABC Limited Journal Date Particulars L.F. Debit Credit Amount Amount Bank A/c 2,70,000 To 12% Debenture Application A/c (Application money on 9,000 debentures received) 2,70,000 12% Debenture Application A/c 2,70,000 To 12% Debentures A/c 2,70,000 (Application money transferred to debentures Account on allotment) 12% Debenture Allotment A/c 6,30,000 To 12% Debentures A/c 6,30,000 (Amount due on 9,000 debentures on Rs 70 per debenture) Bank A/c 6,30,000 To 12% Debenture Allotment A/c 6,30,000 (Amount received on allotment) ABC Limited *Balance Sheet as at... Particulars Note Amount No. I. Equity and Liabilities Non-current liabilities 1 9,00,000 Long-term borrowings II. Assets Current assets Cash and cash equivalents 2 9,00,000 * Relevant data only Notes to Accounts Particulars Amount 1. Long-term borrowings 9,000, 12% Debentures of Rs 100 each 9,00, Cash and cash equivalents Cash at bank 9,00,000

7 80 Accountancy : Company Accounts and Analysis of Financial Statements Issue of Debentures at a Discount When a debenture is issued at a price below its nominal value, it is said to be issued at a discount. For example, the issue of Rs 100 debentures at Rs 95, Rs 5 being the amount of discount. Discount on issue of debentures is a capital loss and over a period of 3 to 5 years or is charged to Securities Premium Account as per the guidelines issued by ICAI. The discount on issue of debentures can be written-off either by debiting it to profit and loss or to securities premium account. The Companies Act, 1956 does not impose any restrictions upon the issue of debentures at a discount. Illustration 2 TV Components Ltd., issued 10,000, 12% debentures of Rs 100 each at a discount of 5% payable as follows: On application Rs 40 On allotment Rs 55 Show the journal entries including those for cash, assuming that all the instalments were duly collected. Also show the relevant portion of the balance sheet. Solution: Books of TV Components Ltd. Journal Date Particulars L.F. Debit Credit Amount Amount Bank A/c 4,00,000 To 12% Debenture Application A/c 4,00,000 (Receipt of application Rs 30 per debenture) 12% Debenture Application A/c 4,00,000 To 12% Debenture A/c 4,00,000 (Transfer of application money to debenture account) 12% Debenture Allotment A/c 5,50,000 Discount on Issue of Debentures A/c 50,000 To 12% Debenture A/c 6,00,000 (Allotment money due on debentures) Bank A/c 5,50,000 To 12% Debenture Allotment A/c 5,50,000 (Receipt of allotment money on debentures)

8 Issue and Redemption of Debentures 81 TV Components Limited Balance Sheet as at... Particulars Note Amount No. I. Equity and Liabilities 1. Non-current Liabilities Long-term borrowings 1 10,00,000 II. Assets 1. Non-current assets Other non-current assets 2 45, Current assets a) Cash and cash equivalents 3 9,50,000 b) Other current assets 4 5,000 10,00,000 Notes to Accounts Particulars Amount 1. Long-term borrowings 10,000, 12% secured debentures of Rs 100 each 10,00, Other non-current assets Discount on issue of debentures 45, Cash and cash equivalents Cash at bank 9,50, Other current assets Discount on issue of debentures (To be written-off within 12 months of the balance sheet date or the period of operating cycle) 5,000 Notes: 1 It is presumed that debentures are redeemable after 10 years. *Relevant data only Debentures issued at Premium A debenture is said to be issued at a premium when the price charged is more than its nominal value. For example, the issue of Rs 100 debentures for Rs 110, (Rs 10 is being the premium). The amount of premium is credited to Securities Premium account and is shown on the liabilities side of the balance sheet under the head Reserves and Surpluses. Illustration 3 XYZ Industries Ltd., issued 2,000, 10% debentures of Rs 100 each, at a premium of Rs 10 per debenture payable as follows: On application Rs 50 On allotment Rs 60

9 82 Accountancy : Company Accounts and Analysis of Financial Statements The debentures were fully subscribed and all money was duly received. Record the journal entries in the books of a company. Show how the amounts will appear in the balance sheet. Solution: Books of XYZ Industries Limited Journal Date Particulars L.F. Debit Credit Amount Amount Bank A/c 1,00,000 To 10% Debenture Application A/c 1,00,000 (Application money Rs 50 per debentures received) 10% Debenture Application A/c 1,00,000 To 10% Debentures A/c 1,00,000 (Transfer of application money ) To debenture A/c 10% Debenture Allotment A/c 1,20,000 To 10% Debentures A/c 1,00,000 To Securities Premium A/c 20,000 (Allotment money due on debentures including the premium) Bank A/c 1,20,000 To 10% Debenture Allotment A/c 1,20,000 (Allotment money received) XYZ Industries Limited Balance Sheet as at Particulars Note Amount No. I. Equity and Liabilities 1. Shareholders Funds Reserve and Surplus 1 20, Non-current Liabilities Long-term borrowings 2 2,00,000 2,20,000 II. Assets Current Assets Cash and cash equivalents 2,20,000

10 Issue and Redemption of Debentures 83 Notes to Accounts Particulars Amount 1. Reserve and surplus Securties Premium 20, Long-term borrowings 2,000, 10% debentures of Rs 100 each 2,00, Cash and cash equivalents Cash at bank 2,20,000 Illustration 4 A Limited issued 5,000, 10% debentures of Rs 100 each, at a premium of Rs 10 per debenture payable as follows: On application Rs 25 On allotment On first and final call Rs 40 Rs 45 (including premium) The debentures were fully subscribed and all money was duly received. Record the necessary entries in the books of the company. Show how the amounts will appear in the balance sheet. Solution: Books of A Limited Journal Date Particulars L.F. Debit Credit Amount Amount Bank A/c 1,25,000 To 10% Debenture Application A/c 1,25,000 (Application money on 10% debentures received) 10% Debenture Application A/c 1,25,000 To 10% Debentures A/c 1,25,000 (Transfer of application money on allotment) 10% Debenture Allotment A/c 2,25,000 To 10% Debentures A/c 1,75,000 To Securities Premium A/c 50,000 (Allotment money of due on debentures including the premium)

11 84 Accountancy : Company Accounts and Analysis of Financial Statements Bank A/c 2,25,000 To 10% Debenture Allotment A/c 2,25,000 (Allotment money received) 10% Debenture First & Final Call A/c 2,00,000 To 10% Debentures A/c 2,00,000 (First and final call money due on debentures) Bank A/c 2,00,000 To 10% Debenture First & Final Call A/c 2,00,000 (First and final call money received) A Limited Balance Sheet as at Particulars Note Amount No. I. Equity and Liabilities 1. Shareholders Funds a) Reserve and Surplus 1 50, Non-current Liabilities Long term borrowings 2 5,00,000 Total 5,50,000 II. Assets 1. Current assets a) Cash and cash equivalents 5,50,000 Notes to Accounts Particulars Amount 1. Reserve and surplus Securities premium 50, Long-term borrowings 5,000, 10% debentures of Rs 100 each 5,00, Over Subscription When the number of debentures applied for is more than the number of debentures offered to the public, the issue is said to be over subscribed. A company, however, cannot allot more debentures than it has invited for subscription. The excess money received on over subscription may, however, be retained for adjustment towards allotment and the respective calls to be made. But the money received from applicants to whom no debentures have been allotted, will be refunded to them.

12 Issue and Redemption of Debentures 85 Illustration 5 X Limited Issued 10,000, 12% debentures of Rs 100 each payable Rs 40 on application and Rs 60 on allotment. The public applied for 14,000 debentures. Applications for 9,000 debentures were accepted in full; applications for 2,000 debentures were allotted 1,000 debentures and the remaining applications, were rejected. All money was duly received. Journalise the transactions. Solution: Books of X Limited Journal Date Particulars L.F. Debit Credit Amount Amount Bank A/c 5,60,000 To 12% Debenture Application A/c 5,60,000 (Receipt of application money on 14,000 debentures) 12% Debenture Application A/c 5,60,000 To 12% Debentures A/c 4,00,000 To Debentures Allotment A/c 40,000 To Bank A/c 1,20,000 (Debenture Application money transferred to Debenuture A/c, Excess application money credited to Debenture Allotment account and money refunded on rejected application) 12% Debenture Allotment A/c 6,00,000 To 12% Debentures A/c 6,00,000 (Amount due on allotment on 10,000 debentures) Bank A/c 5,60,000 To Debenture Allotment A/c 5,60,000 (Allotment money received)

13 86 Accountancy : Company Accounts and Analysis of Financial Statements 2.6 Issue of Debentures for Consideration other than Cash Sometimes a company purchase assets from vendors and instead of making payment in cash issues debentures for consideration thereof. Such issue of debentures is called debentures issued for consideration other than cash. In that case also, the debentures may be issued at par, at a premium or at a discount then entries made in such a situation are similar to those of the shares issued for consideration other than cash, which are as follows : 1. On purchase of assets Sundry Assets A/c To Vendor s 2. On issue of debentures (a) At par Vendors To Debentures A/c (b) At premium Vendors To Debentures A/c To Securities Premium A/c (c) At a discount Vendors Discount on Issue of Debenture A/c To Debentures A/c Illustration 6 Aashirward Company Limited purchased assets of the book value of Rs 2,00,000 from another company and agreed to make the payment of purchase consideration by issuing 2,000, 10% debentures of Rs 100 each. Record the necessary journal entries. Solution: Books of Aashirwad Company Limited Journal Date Particulars L.F. Debit Credit Amount Amount Sundry Assets A/c 2,00,000 To Vendors 2,00,000 (Assets purchased from vendors) Vendors 2,00,000 To 10% Debentures A/c 2,00,000 (Allotment of debentures to vendors as purchase consideration)

14 Issue and Redemption of Debentures 87 Illustration 7 Rai Company purchased assets of the book value of Rs 2,20,000 from another company and agreed to make the payment of purchase consideration by issuing 2,000, 10% debentures of Rs 100 each at a premium of 10%. Record necessary journal entries. Solution: Books of Rai Company Limited Journal Date Particulars L.F. Debit Credit Amount Amount Illustration 8 Sundry Assets A/c 2,20,000 To Vendors 2,20,000 (Assets purchased from vendors) Vendors 2,20,000 To 10% Debentures A/c 2,00,000 To Securities Premium A/c 20,000 (Allotment of 2,000 debentures of Rs 100 each at a premium of 10% as purchase consideration) National Packaging Company purchased assets of the value of Rs 1,90,000 from another company and agreed to make the payment of purchase consideration by issuing 2,000, 10% debentures of Rs 100 each at a discount of 5%. Record necessary journal entries. Solution: Books of National Packaging Company Journal Date Particulars L.F. Debit Credit Amount Amount Sundry Assets A/c 1,90,000 To Vendors 1,90,000 (Assets purchased from vendors) Vendors 1,90,000 Discount on Issue of Debenture A/c 10,000 To 10% Debentures A/c 2,00,000 (Allotment of 2,000 debentures of Rs 100 each at a discount of 5% as purchase consideration)

15 88 Accountancy : Company Accounts and Analysis of Financial Statements Illustration 9 G.S.Rai company purchased assets of the book value of Rs 99,000 from another firm. It was agreed that purchase consideration be paid by issuing 11% debentures of Rs 100 each. Assume debentures have been issued. 1. At par 2. At discount of 10%, and 3. At a premium of 10%. Record necessary journal entries. Solution: Books of G.S.Rai Company Limited Journal Date Particulars L.F. Debit Credit Amount Amount Sundry Assets A/c 99,000 To Vendors 99,000 (Assets purchased from vendors) In Ist Vendors 99,000 Case To 10% Debentures A/c 99,000 (Allotment of debentures to vendors as purchase consideration) In IInd Vendors 99,000 Case Discount on Issue of Debenture A/c 11,000 To 10% Debentures A/c 1,10,000 (Allotment of 1,100 debenture of Rs 100 issued at discount of 10% to vendor) In IIIrd Vendors 99,000 Case To 11% Debentures A/c 90,000 To Securities Premium A/c 9,000 (Allotment of 900 debentures of Rs 100 issued at a premium of 10% to the vendors) Sometimes a company may purchase the assets as well as takeover its liabilities of another concern. It happens usually in case of purchase of the whole business of the other concern. In such a situation, the purchase consideration will be equal to the value of net assets (Assets - Liabilities) taken over, and if the whole amount of the consideration is paid by issue of debentures, the journal entry will be:

16 Issue and Redemption of Debentures 89 Sundry Assets A/c To Sundry Liabilities A/c To Vendors (Purchase of the Vendors business) Illustration 10 Romi Ltd. acquired assets of Rs 20 lakh and took over creditors of Rs 2 lakh from Kapil Enterprises. Romi Ltd. issued 8% debentures of Rs 100 each at par as purchase consideration. Record necessary journal entries in the books of Romi Ltd. Solution: Books of Romi Ltd. Journal Date Particulars L.F. Debit Credit Amount Amount Sundry Assets A/c 20,00,000 To Kapil Enterprises 18,00,000 To Sundry Creditors A/c 2,00,000 (Purchase of business from Kapil Enterprises) Kapil Enterprises 18,00,000 To 8% Debentures A/c 18,00,000 (Issue of 18,000, 8% debentures of Rs 100 each) In case of the whole business being taken over if the amount of debentures issued is more than the amount of the net assets taken over, the difference (excess) will be treated as value of goodwill and the same shall also be debited while passing the journal entry for the purchase of vender s business (see Illustration 10). But if it is the other way round, i.e., the value of debentures is less than the value of the net assets taken over the difference will be credited to capital Reserve accounts (See Illustration 12). Illustration 11 Blue Prints Ltd., purchased building worth Rs 1,50,000, machinery worth Rs 1,40,000 and furniture worth Rs 10,000 from XYZ Co., and took over its liabilities of Rs 20,000 for a purchase consideration of Rs 3,15,000. Blue Prints Ltd., paid the purchase consideration by issuing 12% debentures of Rs 100 each at a premium of 5%. Record necessary journal entries.

17 90 Accountancy : Company Accounts and Analysis of Financial Statements Solution: Books of Blue Prints Limited Journal Date Particulars L.F. Debit Credit Amount Amount Note: Building A/c 1,50,000 Plant & Machinery A/c 1,40,000 Furniture A/c 10,000 Goodwill A/c 1 35,000 To Liabilities (Sundry) 20,000 To XYZ Co. 3,15,000 (Purchase of assets and taking over of liabilities of XYZ Co.) XYZ Co. 3,15,000 To 12% Debentures A/c 3,00,000 To Securities Premium A/c 15,000 (Issue of 3,000 debentures at a premium of 5%) 1. Since the purchase consideration is more than net assets taken over, the difference has been debited to goodwill account. 2. No. of debentures issued = Purchase Consideration Issue Price of a Debenture Illustration 12 = Rs 3,15,000 = 3, A Limited took over the assets of Rs 3,00,000 and liabilities of Rs 10,000 from B & Co. Ltd. for an agreed purchase consideration of Rs 2,70,000 to be satisfied by issue of 15% debentures of Rs 100 at 20% premium. Show the journal entries in the journal of A Limited. Solution: Books of A Limited Journal Date Particulars L.F. Debit Credit Amount Amount Sundry Assets A/c 3,00,000 To Sundry Liabilities A/c 10,000 To B & Co. Ltd. 2,70,000 To Capital Reserve 20,000 (Purchased assets and took over liabilities from B Ltd.)

18 Issue and Redemption of Debentures 91 B & Co. Ltd. 2,70,000 To 15% Debentures A/c 2,25,000 To Securities Premium A/c 45,000 (Issue of 2,250 debentures of Rs 100 each at a premium of 20%) Do it Yourself 1. Amrit Company Limited purchased assets of the value of Rs 2,20,000 from another company and agreed to make the payment of purchase consideration by issuing 2,000, 10% debentures of Rs 100 each at a premium of 10%. Record necessary journal entries. 2. A company purchased assets of the value of Rs 1,90,000 from another company and agreed to make the payment of purchase consideration by issuing 2,000, 10% debentures of Rs 100 each at a discount of 5%. Record necessary journal entries. 3. Rose Bond Limited purchased a business for Rs 22,00,000. Purchase Price was paid by 6% debentures. Debentures of Rs 20,00,000 were issued at a premium of 10% for the purpose. Record necessary journal entries. 4. Nikhil and Ashwin Limited bought business of Agarwal Limited consisting sundry assts of Rs 3,60,000, sundry creditors Rs 1,00,000 for a consideration of Rs 3,07,200. It issued 14% debentures of Rs 100 each fully paid at a discount of 4% in satisfaction of purchase consideration. Record necessary journal entries. Illustration 13 Suvidha Ltd. purchased machinery worth Rs 1,98,000 from Suppliers Ltd. The payment was made by issue of 12% debentures of Rs 100 each. Pass the necessary journal entries for the purchase of machinery and issue of debentures when: (i) Debentures are issued at par; (ii) Debentures are issued at 10% discount; and (iii) Debentures are issued at 10% premium Solution: Books of Suvidha Ltd. Journal Date Particulars L.F. Debit Credit Amount Amount Machinery A/c 1,98,000 To Suppliers Ltd. 1,98,000 (Machinery purchased)

19 92 Accountancy : Company Accounts and Analysis of Financial Statements Case (i) When debentures are issued at par: Suppliers Ltd. 1,98,000 To 12% Debentures A/c 1,98,000 (12% Debentures issued to Suppliers Ltd.) Case (ii) When debentures are issued at 10% discount: Suppliers Ltd. 1,98,000 Discount on Issue of Debentures A/c 22,000 To 12% Debentures A/c 2,20,000 (12% Debentures issued to Suppliers Ltd. at 10% discount) Case (iii) When debentures are issued at 10% premium: Workings: (a) Suppliers Ltd. 1,98,000 To 12% Debentures A/c 1,80,000 To Premium on Issue of Debentures A/c 18,000 (12% Debentures issued to Suppliers Ltd. at 10% premium) Face value of debenture 100 Less: Discount 10% 10 Value at which debenture issued 90 Rs. 1,98,000 Number of debentures issued in case of 10% discount = 90 = 2,200 debenture (b) Face value of debenture 100 Add: Premium 10% 10 Value at which debenture issued 110 Number of debentures issued in case of 10% premium = Rs.1,98, = 1,800 Debentures 2.7 Issue of Debentures as a Collateral Security A collateral security may be defined as a subsidiary or secondary or additional security besides the primary security when a company obtains a loan or overdraft from a bank or any other financial Institution. It may pledge or mortgage some assets as a secured loan against the said loan. But the lending institutions may

20 Issue and Redemption of Debentures 93 insist on additional assets as collateral security so that the amount of loan can be realised in full with the help of collateral security in case the amount from the sale of principal security falls short of the loan money. In such situation, the company may issue its own debentures to the lenders in addition to some other assets already pledged. Such an issue of debentures is known as Debentures issued as Collateral Security. If the company fails to repay the loan along with interest, the lender is free to receive his money from the sale of primary security and if the realisable value of the primary security falls short to cover the entire amount, the lender has the right to invoke the benefit of collateral security whereby debentures may either be presented for redemption or sold in the open market. Debentures issued as collateral security can be dealt within two ways in the books of the company: First Method No entry is made in the books of accounts since no liability is created by such issue. However, on the liability side of the balance sheet, below the item of loan, a note to the effect that it has been secured by issue of debentures as a collateral security is appended. For example, X Company has issued 9%, 10,000 debentures of Rs 100 each for a loan of Rs 10, 00,000 taken from a bank. This fact may be shown in the balance sheet as under: X Company Balance Sheet as at Particulars Note Amount No. I. Equity and Liabilities 1. Non-current Liabilities Long-term borrowings 1 10,00,000 Notes to Accounts Particulars Amount 1. Long-term borrowings Bank Loan (Secured by issue of 10,000, 10% debentures 10,00,000 of Rs 10 each as Collatoral Security) Second Method The issue of debentures as a collateral security may be recorded by means of journal entry as follows:

21 94 Accountancy : Company Accounts and Analysis of Financial Statements Journal Entries i. Issue of 10,000, 9% debentures of Rs 100 each as collateral security for bank loan of Rs 10,00,000. Debenture Suspense A/c 10,00,000 To 9% Debentures A/c 10,00,000 ii. For cancellation of 9% debentures as collateral security on repayment of bank loan. Debenture Suspense account will appear as a deduction from the debentures on the liability side of the balance sheet. When loan is repaid the above entry will be cancelled by a reverse entry : 9% Debentures A/c 10,00,000 To Debenture Suspense A/c 10,00,000 Balance Sheet of X Co. (Extract) Particulars Note Amount No. I. Equity and Liabilities 1. Non-current Liabilities Long term borrowings 1 10,00,000 Notes to Accounts Particulars Amount 1. Long term borrowings 10,00,000 Bank loan 10,000, 9% debentures of Rs 100 each 10,00,000 Less: Debenture suspense 10,00,000 10,00,000 Illustration 14 A company took a loan of Rs 10,00,000 from Punjab National Bank and issued 10% debentures of Rs 12,00,000 of Rs 100 each as a collateral security. Explain how you will deal with the issue of debentures in the books of the company.

22 Issue and Redemption of Debentures 95 Solution: First Method: Balance Sheet (Extract) Particulars Note Amount No. I. Equity and Liabilities 1. Non-current Liabilities Long-term borrowings 1 10,00,000 Notes to Accounts Particulars Amount 1. Long-term borrowings Bank loan 10,00,000 (Secured by issue of 12,000, 10% debentures of Rs 100 each as Collatoral Security Second Method: Journal Entries Date Particulars L.F. Debit Credit Amount Amount Debenture Suspense A/c 12,00,000 To 10% Debentures A/c 12,00,000 (12,000 debenture of Rs 100 each issued as collateral security to P.N.Bank) Balance Sheet (Extract) Particulars Note Amount No. I. Equity and Liabilities 1. Non-current Liabilities Long-term borrowings 1 10,00,000 Notes to Accounts Particulars Amount 1. Long-term borrowings Secured Loan from 10,00,000 PNB 12,000, 10% debentures of 12,00,000 Rs 100 each Less: Debenture Suspense 12,00,000 10,00,000

23 96 Accountancy : Company Accounts and Analysis of Financial Statements Do it Yourself 1. Raghuveer Limited issued Rs 10,00,000, 8% debentures as follows to: Rs 1. Sundry Subscribers for Cash at 90% 5,50, Vendor of Machinery for Rs 2,00,000 2,00,000 in satisfaction of his claim 3. Bankers as Collateral Security for a bank loan 2,50,000 worth Rs 20,00,000 for which principal security is Business Premises worth Rs 22,50,000. The issue (1) and (2) are redeemable at the end of 10 years at par. State how the debenture will be dealt with while preparing the balance sheet of a company. 2. Hassan Limited took a loan of Rs 30,00,000 from a bank against primary security worth Rs 40,00,000 and issued 4,000, 6% debentures of Rs 100 each as a collateral security. The company again after one year took a loan of Rs 50,00,000 from bank against Plant as primary security and deposited 6,000, 6% debentures of Rs 100 each as collateral security. Record necessary journal entries and prepare balance sheet of the company. 3. Meghnath Limited took a loan of Rs 1,20,000 from a bank and deposited 1,400, 8% debentures of Rs 100 each as collateral security along with primary security worth Rs 2 lakh. Company again took a loan of Rs 80,000 after two months from a bank and deposited 1,000, 8% debentures of Rs 100 each as collateral security. Record necessary journal entries and prepare balance sheet of the company. 2.8 Terms of Issue of Debentures When a company issues debentures, it usually mentions the terms on which they will be redeemed on their maturity. Redemption of debentures means discharge of liability on account of debentures by repayment made to the debentureholders Debentures can be redeemed either at par or at a premium. Depending upon the terms and conditions of issue and redemption of debentures, the following six situations are commonly found in practice. (i) (ii) (iii) (iv) (v) (vi) Issued at par and redeemable at par Issued at discount and redeemable at par Issued at a premium and redeemable at par Issued at par and redeemable at a premium Issued at a discount and redeemable at a premium Issued at a premium and redeemable at a premium In all the above six cases, the following journal entries will be passed:

24 Issue and Redemption of Debentures Issue at par and redeemable at par (a) Bank A/c To Debenture Application & Allotment A/c (Receipt of application money) (b) Debenture Application & Allotment A/c To Debentures A/c (Allotment of debentures) 2. Issue at a discount and redeemable at par (a) Bank A/c To Debenture Application & Allotment A/c (Receipt of application money) (b) Debenture Application & Allotment A/c Discount on Issue of Debentures A/c To Debentures A/c (Allotment of debentures at a discount) 3. Issue at premium and redemption at par (a) Bank A/c To Debenture Application & Allotment A/c (Receipt of application money) (b) Debenture Application & Allotment A/c To Debentures A/c To Securities Premium A/c (Allotment of debentures at a premium) 4. Issue at par and redeemable at premium (a) Bank A/c To Debenture Application & Allotment A/c (Receipt of application money) (b) Debenture Application & Allotment A/c Loss on Issue of Debentures A/c To Debentures A/c To Premium on Redemption of Debenture A/c (Allotment of debentures at par and redeemade at a premium) (with premium on redemption) (with nominal value of debenture) (with premium on redemption)

25 98 Accountancy : Company Accounts and Analysis of Financial Statements 5. Issue at discount and redemption at premium Bank A/c To Debenture Application & Allotment A/c (Receipt of application money) Debenture Application & Allotment A/c Loss on Issue of Debentures A/c To Debentures A/c To Premium on Redemption of Debentures A/c (Allotment of debentures at a discount and redeemable at premium) (with discount on issue plus premium on redemption) (with nominal value of debenture) (with premium on redemption) 6. Issued at a premium and redeemable at premium Bank A/c To Debenture Application & Allotment A/c (Receipt of application money) Debenture Application & Allotment A/c Loss on Issue of Debentures A/c (with premium on redemption) To Debentures A/c (with nominal value of debenture) To Securities Premium A/c (with premium on issue) To Premium on Redemption of (with premium on redemption) Debentures A/c Notes: 1. When debentures are redeemable at a premium, a provision has to be made right at the time of the issue by debiting the amount to Loss on Issue of Debentures A/c. It may be noted that when debentures are issued at a discount and are redeemable at a premium, the amount of discount on issue is also debited to Loss on Issue of Debentures. It may be noted that when the debentures are issued at a discount and are redeemable at par, the amount debited to Discount on Issue of Debentures A/c as usual. 2. Premium on redemption is a liability of a company payable in future. It is a provision and is shown under the head Non-current liabilities under subhead Long-term Borrowings until debentures are redeemed. 3. Loss on issue of debentures is a capital loss and it is to be written-off gradually charged to statement of profit and loss or securities premium account. Illustration 15 Give Journal entries for the following: 1. Issue of Rs 1,00,000, 9% debentures of Rs 100 each at par and redeemable at par.

26 Issue and Redemption of Debentures Issue of Rs 1,00,000, 9% debentures of Rs 100 each at premium of 5% but redeemable at par. 3. Issue of Rs 1,00,000, 9% debentures of Rs 100 each at discount of 5% repayable at par. 4. Issue of Rs 1,00,000, 9% debentures of Rs 100 each at par but repayable at a premium of 5%. 5. Issue of Rs 1,00,000, 9% debentures of Rs 100 each at discount of 5% but redeemable at premium of 5%. 6. Issue of Rs 1,00,000, 9% debentures of Rs 100 each at premium of 5% and redeemable at premium of 5%. Solution: Journal Date Particulars L.F. Debit Credit Amount Amount 1 Bank A/c 1,00,000 To 9% Debenture Application & Allotment A/c 1,00,000 (Debentures Application money received) Debenture Application & Allotment A/c 1,00,000 To 9% Debentures A/c 1,00,000 (Application money transferred to Debentures Account) 2 Bank A/c 1,05,000 To 9% Debenture Application & Allotment A/c 1,05,000 (Debentures application money received) Debenture Application & Allotment A/c 1,05,000 To 9% Debentures A/c 1,00,000 To Securities Premium A/c 5,000 (Debentures application money transferred to Debentures & Securities Premium account) 3 Bank A/c 95,000 To 9% Debenture Application & Allotment A/c 95,000 (Debentures application money received) 9% Debenture Application & Allotment A/c 95,000 Discount on Issue of Debentures A/c 5,000 To 9% Debentures A/c 1,00,000 (Debentures application money transferred to Debentures account)

27 100 Accountancy : Company Accounts and Analysis of Financial Statements 4 Bank A/c 1,00,000 To 9% Debenture Application & Allotment A/c 1,00,000 (Debentures Application money received) Debenture Application & Allotment A/c 1,00,000 Loss on Issue of Debentures A/c 5,000 To 9% Debentures A/c 1,00,000 To Premium on Redemption of Debentures A/c 5,000 (Debentures Application money transferred to Debentures account) 5 Bank A/c 95,000 To 9% Debenture Application & Allotment A/c 95,000 (Debentures Application money received) Debenture Application & Allotment A/c 95,000 Loss on Issue of Debentures A/c 10,000 To 9% Debentures A/c 1,00,000 To Premium on Redemption of Debentures A/c 5,000 (Debentures application money transferred to debentures and Premium on debenture account) 6 Bank A/c 1,05,000 To 9% Debenture Application & Allotment A/c 1,05,000 (Debentures Application money received) Debenture Application & Allotment A/c 1,05,000 Loss on Issue of Debentures A/c 5,000 To 9% Debenture A/c 1,00,000 To Premium on Redemption of Debentures A/c 5,000 To Securities Premium A/c 5,000 (Debenture application money transferred to debentures account) Illustration 16 You are required to pass the journal entries relating to the issue of the debentures in the books of X Ltd., and show how they would appear in its balance sheet under the following cases: (a) (b) 120, 8% debentures of Rs 1,000 each are issued at 5% discount and repayable at par. 150, 7% debentures of Rs 1,000 each are issued at 5% discount and repayable at premium of 10%.

28 Issue and Redemption of Debentures 101 (c) (d) 80, 9% debentures of Rs 1,000 each are issued at 5% premium. Another 400, 8% debentures of Rs 100 each are issued as collateral security against a loan of Rs 40,000. Solution: (a) Books of X Ltd. Journal Date Particulars L.F. Debit Credit Amount Amount Bank A/c 1,14,000 Discount on issue of Debentures A/c 6,000 To 8% Debentures A/c 1,20,000 (Issue of 120, 8% debentures at a discount of 5% repayable at par) Books of X Ltd. Balance Sheet as at Particulars Note Amount No. I. Equity and Liabilities 1. Non-current Liabilities Long-term borrowings 1 1,20,000 1,20,000 II. Assets 1. Non-current assets Other non-current assets 2 4, Current assets Cash and cash equivalents 3 1,14,000 Other current assets 4 1,200 1,20,000 Notes to Accounts Particulars Amount 1. Long-term borrowings 120, 8% debentures of Rs 1,000 each 1,20, Other non-current assets Discount on issue of debentures 4, Cash and cash equivalents Cash at bank 1,14, Other current assets Discount on issue of debentures 1,200 Note: Discount on Issue of Debentures is written-off in 5 years, presuming that debentures are redeemable after 5 years.

29 102 Accountancy : Company Accounts and Analysis of Financial Statements (b) Books of X Ltd. Journal Date Particulars L.F. Debit Credit Amount Amount Bank A/c 1,42,500 Loss on Issue of Debentures A/c 22,500* To 7% Debentures A/c 1,50,000 To Premium on Redemption of 15,000 Debenture A/c (Issue of 150, 7% debentures at a discount of 5% repayable at premium of 10%) * Discount on issue of debentures Rs 7,500 and premium on redemption of debentures Rs 15,000. Books of X Ltd. Balance Sheet as at Particulars Note Amount No. I. Equity and Liabilities 1. Non-current Liabilities a) Long-term borrowings 1 1,50,000 b) Other long-term liabilities 2 15,000 1,65,000 II. Assets 1. Non-current assets Other non-current assets 3 18, Current assets a) Cash and cash equivalents 4 1,42,500 b) Other current assets 5 4,500 1,65,000 Notes to Accounts Particulars Amount 1. Long-term borrowings 150, 7% debentures of Rs 1,000 each 1,50, Other long-term liabilities Premium on redemption of debentures 15, Other non-current assets Loss on issue of debentures 18, Cash and cash equivalents Cash at bank 1,42, Other current assets Loss on issue of debentures 4,500

30 Issue and Redemption of Debentures 103 Note: Discount on Issue of Debentures is written-off in 5 years, presuming that debentures are redeemable after 5 years. Books of X Ltd. (c) Journal Date Particulars L.F. Debit Credit Amount Amount Bank A/c 84,000 To 9% Debentures A/c 80,000 To Securities premium A/c 4,000 (Issue of 80, 9% debentures of Rs 1,000 each at 5% premium) X Ltd. Balance Sheet as at... Particulars Note Amount No. I. Equity and Liabilities 1. Shareholder s funds Reserves and surplus 1 4, Non-current Liabilities Long-term borrowings 2 80,000 84,000 II. Assets 1. Current assets Cash and cash equivalents 3 84,000 84,000 Notes to Accounts Particulars Amount 1. Reserves and surplus Securities premium reserve 4, Long-term borrowings 80, 9% debentures of Rs 1,000 each 80,000 Books of X Ltd. (d) Journal Date Particulars L.F. Debit Credit Amount Amount Debenture Suspense A/c 40,000 To 8% Debentures A/c 40,000 (Issue of 400, 8% debentures of Rs 100 each as collateral security against a loan of Rs 40,000)

31 104 Accountancy : Company Accounts and Analysis of Financial Statements X Ltd. Balance Sheet as at (Extract) Particulars Note Amount No. I. Equity and Liabilities 1. Long-term borrowings 1 40,000 Notes to Accounts Particulars Amount Amount 1. Long-term borrowings Bank loan 40, , 8% debentures of Rs 100 each 40,000 Less: Debentures suspense 40,000-40,000 Do it Yourself 1. Nena Limited issued 50,000, 10% debentures of Rs 100 each on the basis of the following conditions: a. Debentures issued at par and redeemable at par. b. Debentures issued at 5% and redeemable at par. c. Debentures issued at 10% and redeemable at par. d. Debentures issued at par and redeemable at 10%. e. Debentures issued at discount of 5% and redeemable at a premium of 10%. f. Debentures issued at premium of 6% and redeemable at a premium of 4%. Record necessary journal entries in the above mentioned cases at the time of issue and redemption of debentures. 2. Record necessary journal entries in each of the following cases: a. 27,000, 7% debentures of Rs 100 each issued at par, redeemable at par. b. 25,000, 7% debentures of Rs 100 each issued at par redeemable at 4% premium. c. 20,000, 7% debentures of Rs 100 each issued at 5% discount and redeemable at par. d. 30,000, 7% debentures of Rs 100 each issued at 5% discount and redeemable at 2½ % premium. e. 35,000, 7% debentures of Rs 100 each issued at 4% premium and redeemable at premium of 5%. 2.9 Interest on Debentures When a company issues debentures, it is under an obligation to pay interest thereon at fixed percentage (half yearly) periodically until debentures are repaid. This percentage is usually as part of the name of debentures like 8% debentures, 10%

32 Issue and Redemption of Debentures 105 debentures, etc., and interest payable is calculated at the nominal value of debentures. Interest on debenture is a charge against the profit of the company and must be paid whether the company has earned any profit or not. According to Income Tax Act, 1961, a company must deduct income tax at a prescribed rate from the interest payable on debentures if it exceeds the prescribed limit. It is called Tax Deducted at Source (TDS) and is to be deposited with the tax authorities. Of course, the debentureholders can adjust this amount against the tax due from them Accounting Treatment The following journal entries are recorded in the books of a company in connection with the interest on debentures: 1. When interest is due Debenture Interest A/c To Income Tax payable A/c To Debentureholders A/c (Amount of interest due on debenture and tax deducted at source ) 2. For payment of interest to debentureholders Debentureholders A/c To Bank A/c (Amount of interest paid to debentureholders) 3. On transfer debenture Interest Account to statement of Profit and Loss Profit and Loss A/c To Debenture Interest A/c (Debenture interest transferred to profit and loss A/c) 4. On payment of tax deducted at source to the Government Income Tax Payable A/c To Bank A/c (Payment of tax deducted at source on interest on debentures) Illustration 17 A Ltd., issued 2,000, 10% debentures of Rs 100 each on January 01, 2014 at a discount of 10% redeemable at a premium of 10%. Give journal entries relating to the issue of debentures and debenture interest for the period ending December 31, 2014 assuming that interest was paid half yearly on June 30 and December 31 and tax deducted at source is 10%. A Ltd., follows calendar year as its accounting year.

33 106 Accountancy : Company Accounts and Analysis of Financial Statements Solution: Book of A Ltd. Journal Date Particulars L.F. Debit Credit Amount Amount 2014 Jan.01 Bank A/c 1,80,000 To 10% Debenture Application & 1,80,000 Allotment A/c (Application money received on 2,000, 10% debentures) Jan % Debentures Application & Allotment A/c 1,80,000 Loss on Issue of Debenture A/c 40,000 To 10% Debentures A/c 2,00,000 To Premium on Redemption of 20,000 Debentures A/c (Allotment of debentures at a discount of 10% and redeemable at a premium of 10%) Jun.30 Debenture Interest A/c 10,000 To Debentureholders A/c 9,000 To Income Tax Payable A/c 1,000 (Interest due for 6 months and tax deducted at source) Jun.30 Debenturesholders A/c 9,000 To Bank A/c 9,000 (Payment of interest) Dec.31 Debenture interest A/c 10,000 To Debentureholders A/c 9,000 To Income Tax Payable A/c 1,000 (Interest due for 6 months and tax deducted at source) Dec.31 Debenturesholders A/c 9,000 To Bank A/c 9,000 (Payment of interest) Dec.31 Income Tax Payable A/c 2,000 To Bank A/c 2,000 (Paid tax deducted at source to the government) Dec.31 Statement of profit and loss 20,000 To Debenture Interest A/c 20,000 (Debenture interest transferred to profit and loss account)

34 Issue and Redemption of Debentures 107 Do it Yourself 1. Diwakar enterprises Ltd. Issued 10,00,000, 6% debentures on April 1, Interest is paid on September 30, 2014 and March 31, Record necessary journal entries assuming that income tax is of the amount of interest. 2. Laser India Ltd. Issued 7,00,000, 8% debentures of Rs 100 each at par. Interest is to be paid on these debentures half-yearly on September 30 and March 31, every year. Record necessary journal entries asuming that income tax is 30% of the amount of interest Writing-off Discount/Loss on Issue of Debentures The discount/loss on issue of debentures is a capital loss or a fictitious asset and, therefore, must be written-off during the life time of debentures. The amount of discount/loss on issue of debentures should normally not be written-off in the year of issue itself since the benefit of the debentures would accrue to the company till their redemption. The discount/loss on it is, therefore, treated as capital loss. The discount may be charged to Securities Premium A/c or may be written-off over 3 to 5 years through statement of profit and loss as per guidelines issued by ICAI. Section 78 of the Companies Act, 1956 also permits the utilisation of Securities Premium Account and other capital profits for writing-off the discount/loss on issue of debentures. In case, however, there are no capital profits or if the capital profits are not adequate, the amount of such discount/ loss can be written-off against the revenue profits every year by passing the following journal entry. Statement of Profit and Loss To Discount/Loss on Issue of Debentures A/c (Discount/loss on issue of debentures written-off) Do it Yourself 1. X Ltd. issued 2,000, 10% debentures of Rs 100 each at a discount of 8% on April, 2014 which are redeemable at par by annual drawings in 4 years commencing from March 31, 2015 as per the following redemption plan: Ist Draw 10%, 2nd Draw 20%, 3rd Draw 30%, and 4th Draw 40%. Calculate the amount of discount to be written-off each year assuming that X Ltd., follows calendar year as its accounting year. 2. Z Ltd. issued 15,00,000, 10% debentures of Rs 50 each at premium of 10% payable as Rs 20 on application and balance on allotment. Debentures are redeemable at par after 6 years All the money due on allotment was called and duly received. Record necessary entries when premium money is included: (i) (ii) in application money in allotment money